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ARMs' appeal declines with rates Share down from 59% to 19% of conventional loans since Jan. 1995; Adjustable gives way to fixed; But FHA-backed type is still attracting 1st-time homebuyers


In January of last year, when fixed-rate, 30-year mortgages were sitting above 9 percent nationally, the United States was up in ARMs.

Adjustable-rate mortgages accounted for 59 percent of all conventional loans that month, according to the Federal Housing Finance Board (FHFB), the highest level since 1988. That came as no surprise to lenders, because ARMs could be had for 7 percent or lower.

Since early 1995, however, interest rates have plummeted. Thirty-year fixed-rate conventional mortgages -- loans that aren't government-backed -- dropped below 7 percent recently, although they hiccuped back to 7.32 percent nationally last week, according to a survey by another government agency, Freddie Mac.

Locally, the average 30-year fixed rate is 7.42 percent, according to HSH Associates of Butler, N.J., which surveys Baltimore-area lenders.

This 13-month slide had a predictable effect on adjustable-rate mortgages. Even though conventional ARMs are below 5.5 percent in many parts of the country, and 5.19 percent locally, the number of takers has dropped sharply.

ARMs dipped to 19 percent of conventional loans in November, according to the FHFB.

"ARMs have lost some luster," said David Lereah, chief economist for the Mortgage Bankers Association.

The refinance boomlet has done little for the ARM market, according to Freddie Mac, the Federal Home Loan Mortgage Corp., which buys blocks of mortgages from lenders on the secondary market.

Nearly 60 percent of those refinancing ARMs last year switched to 30-year fixed rates. Another 16 percent switched to 15-year fixed-rate mortgages, which are now below 6.82 percent locally and let buyers build equity faster.

Unlike fixed-rate mortgages, the interest rate and monthly payments of an ARM may increase or decrease over the life of the loan. The interest rate is usually pegged to some index, such as the rate on 1-year U.S. Treasury securities.

Borrowers have flocked to them when interest rates surged, as it became harder for them to qualify for higher fixed-rate mortgages.

While conventional ARMs have dropped in popularity, ARMs insured by the Federal Housing Administration (FHA) are still attracting homebuyers.

"A lot are moving toward FHA ARMs," said Kevin J. Michno, senior vice president of Mercantile Mortgage Corp. of Baltimore.

In the fourth quarter of last year, 31 percent of FHA-insured loans in Maryland (excluding Montgomery and Prince George's counties) were adjustable-rate mortgages. Since Jan. 1, that figure has dipped somewhat but is still 25.9 percent, according to James S. Kelly, an economist at the Maryland office of the U.S. Department of Housing and Urban Development.

Lenders say the FHA-insured ARM has a number of features that make it popular.

Buyers can qualify at the first-year rate, notes Claude Mascari, president of Fountainhead Mortgage Group Ltd. A conventional ARM will typically require that the buyer be qualified at the maximum second-year rate, which could be two points higher than the first year's.

Also, the interest rate can go up only 1 percent annually with the FHA-insured ARM, and no more than 5 percent over the life of the loan.

The FHA ARM is "used very extensively by a lot of our builders," said Mr. Mascari, who sees it as a safer adjustable-rate loan for their first-time buyers because of the 1 percent annual cap.

Also, down payments are low, as little as 2 1/4 percent, according to Iris Rombro, executive vice president and director of production at Fairfax Mortgage Corp.

The FHA will insure loans up to around $152,350, which covers a substantial portion of the first-time homebuyer market, according to Mike Dunn, regional manager for Prosperity Mortgage Co. in Lutherville.

"Our average loan is $110,000," said Mr. Dunn, whose company is an affiliate of Long & Foster Realtors.

At today's rates, taking out an FHA-insured ARM can spell the difference between qualifying for a $110,000 townhome or a $135,000 detached residence, Mr. Dunn said.

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